US President Donald Trump poses the biggest risk to emerging market capital flows, said Barry Eichengreen, the George C. Pardee and Helen N. Pardee professor of economics at the University of California, Berkeley. In town to deliver Exim Bank’s commencement day lecture, Eichengreen said the impact of the Fed raising rates on emerging markets such as India has reduced considerably. Edited excerpts from an interview:
In the past few months, we have seen global risk aversion coming down and a lot of money flowing to emerging markets. What is the big risk to these flows?
There is the (US President Donald) Trump risk. Trump can do something that can be disruptive to global trade flows and financial flows. On the trade policy front, he has a lot of freedom to work unilaterally. He doesn’t have to get Congress’s assent to invoke the Terms of Trade Adjustment Act, which is what Nixon used in 1971 to slap a 15% import surcharge. The US has special forces on the ground in Iraq and Afghanistan. (There) he can invoke the Trading with the Enemy Act, 1917.
Does the Trump risk overshadow everything else?
I think the Trump risk definitely overshadows everything else. There could be an electoral surprise in Europe. I would regard that as a low-probability event because of the two-round presidential election in France, because of the fact that there is considerable support for two centrist candidates in Germany. We have learnt from Brexit and from Trump that low-probability events sometimes do happen. I worry less than I did about the economic and financial problems in China.
Then there are geopolitical shocks. China is a proud country and it will respond (if Trump imposes import taxes). Then what happens to cooperation between US and China on North Korea? If they are fighting a trade war, can they peacefully coordinate, work on the North Korea problem? If they can’t, what happens to North Korea? That is a frightening prospect. Those are things that keep me awake.
Do you think the global recovery people are talking about is really strong? Is this the right time for the US Fed and other central banks to raise rates?
I think it is the right time for the Federal Reserve to raise rates with the US economy growing at potential, with full employment and inflation at target, there is no reason to maintain rates at zero. The argument is different in Japan and Europe where growth has picked up but inflation has not. Those central banks will be slower to taper their quantitative easing, they will be slower to raise interest rates than the Fed.
What risks do these pose to emerging markets?
In terms of risks to emerging markets, it really depends what emerging markets you are talking about. I think the risks have been reduced by the fact that the Fed has really learnt from its mistakes in 2013. When Ben Bernanke announced (the taper), markets were surprised. They kind of reacted with shock and that made life in emerging markets very hard for three months. This time, Fed has been announcing in advance what the path is. Turkey is very much No.1 on my list (in terms of negative impact). The politics there are quite turbulent as well.
How relevant is the issue of advanced economy-emerging markets coordination, especially for central banks in the background of capital flight risk?
Sometimes, that coordination is critically important. In 2008, when the Federal Reserve extended a $40 billion swap line to Mexico, Brazil and South Korea, it famously didn’t extend it to India. That was an example of cooperation of the US central bank and a few of its friends but was not systematic or universal. To my mind, you not only need central bank coordination, you also need extended IMF facilities because relying on the Fed could mean relying on a whole set of personalities and I think emerging markets will feel safer and more secure if they can rely on the managing director of IMF.
